Is stock split beneficial?

May 12, 2017

A friend of mine, who is a long term investor in stock market, had once bought 100 shares of Axis Bank at the rate of Rs. 1100 per share. One day he called me and inquired on an anxious tone- “Why Axis Bank price has fallen drastically? Is there any problem with the bank?”. On that particular day, Axis Bank has announced a reduction in face value from Rs. 10 to Rs. 2. After explaining him about the stock splitting due which the price has fallen, he happily disconnected as his 100 shares have now become 500.

In recent times, front-line companies have been involved in splitting of their stocks. In 2000-01, many software companies carried out stock splitting. Later in 2005-07, a large number of Real Estate companies involved in splitting of the stocks. Around 2014-15, many banks have followed suit. Let’s see why companies are going for stock splits.

Face Value of the Stock

In order to begin a business, the fund required is raised from bank loans, issuing the shares or collecting money from other sources. For example, consider a company that issues 1 crore shares and collects 10 crore in funding. Total capital raised divided by the number of shares issued gives the face value of the share. In this example, 10 crore / 1 crore = 10. Hence, Face value of the share is Rs. 10.

Stock Price

The value of the stock when being traded in the exchange is termed as stock price. Face value can change only when the company decides to make a change. But stock price varies daily when traded in the stock exchange.

Stock Split

When a company reduces the face value of the stock thereby increasing the total number of shares of the company is known as stock split.

Let us assume that a company trading at Rs. 50 per share has a face value of Rs.10 and 1 crore shares in total. If the company intends to reduce the face value from Rs.10 to Rs.2, the stock split is in the ratio 1:5. This means that the number of shares of the company is going to increase 5 fold to 5 crore shares. The stock price will reduce to Rs.10 per share. So, from the investor point of view there is no change in the investment made. In simpler terms, if you have Rs.100, it can be in any denominations like 2 Rs.50 notes or 5 Rs.10 notes or 10 Rs.5 notes. The count doesn’t matter as the value remains the same. Similarly, regardless of the stock split ratio, the value of the investment won’t have any impact. In case of holding shares on physical certificates, the existing certificates should be surrendered so as to get new certificates with the revised face value.

Why stock split?

Many companies go for stock splits when the stock is trading at a very high value which makes it difficult for the retail investors to invest in their company. If stock split is made, the share price becomes affordable for the retail investors. When a stock price rises consistently, certain investors think that the company is operating on huge profits and hence the price of the stock will continue to increase in future. But, this is a wrong approach.

Let’s look at the performance of some stocks after split. Bharati Airtel announced stock split on 24/07/09. Face value was reduced from Rs. 10 to Rs. 5 and hence split was in the ratio 1:2. On 24/7/09 the stock traded at Rs. 415.50. But a year after splitting, on 23/7/10, the stock price was only Rs.313. 70. It has almost fallen 25%. After stock split, the average trade volume increased from 6.9 Lakhs to 20.13 Lakhs. It should also be noted that the company reported a profit of Rs. 2687.5 crore in June 2009 quarter, which is 31.3 % higher than Rs. 2046.79 crore that was reported an year before.

Taking another example of Asian Paints, which announced a stock split in the ratio 1:10 on 30/7/13, the face value was reduced from Rs. 10 to Re. 1. Just before splitting, the stock traded at Rs. 5118.20. But right after splitting the stock value was Rs. 510.75. Though the stock touched a low of Rs.395 post-split, after one year the stock price raised upto Rs. 644 on 30/7/14. As per a research, 50% of stocks fall after stock split. Certain stocks have fallen drastically. A few examples are GMR infra, Suzlon and Jai Corp. The company’s internal operations and financial situations also could have been the reason behind the fall in prices.

Benefits for investors

There are many be advantages for investors when the stocks are split. Regardless of the share price after split, there will be considerable improvement in trade volumes. If you check the stocks that are traded on very on volumes, there will a vast difference between buy and sell bids. Operators can easily manipulate the price by buying/selling in the price they desire and thereby misleading the retail investors. When there is huge volume being traded, there will be much lesser gap between buying and selling bids. This is highly beneficial as the investor can determine the right value for the stock. Also, this prevents the price of the stock being exaggerated by the operators. As the face value is reduced, a large number of investors will be interesting in buying the stock as the price would have fallen.

Points to be noted

Following points should be kept in mind when dealing with split stocks.

• Stock split has no impact on the company’s operations or performance. • There is no connection between stock split and increase in price of the stock. • The price at which the share is traded solely depends on country’s economy, situation in stock market and the company’s performance. • One should not go for a stock just because the company has decided a stock split. The stock should be bought in a correction after split and the investor should continue to watch the performance of the company.